Speedometers and Forecasts

Photo Credit: myoldpostcards via Compfight (Creative Commons)

by Ted Brooks (Guest Author)

I’ve been watching the relentless climb of the market this past month. Almost every day, it’s notching another decent though not astounding gain. But, start adding them up, and before we know it, a pretty good-sized move is in gear.

Meanwhile, you’ve been monitoring the return forecasts gauged by MIPAR (our median return composite forecast based on approximately 2400 analyses of stocks, Manifest Investing Projected Annual Return), the Value Line Median Appreciation Projection (VLMAP) and in recent times — the Value Line low total return forecast (VLLTR.) You haven’t pressed the alarm yet, but you’re probably eyeballing the alarm button.

One thing I’ve learned is –- no tool is perfect. That includes MIPAR or the Value Line-based close cousins.

That being said – a relatively simple tool that works reliably in most circumstances is a very valuable tool. As far as overpriced vs. underpriced, I think MIPAR tends to “cut through the crap” and give a fast and fairly reliable look at the relative giddiness or gloom of the market. Granted, the inputs may get a little skewed from time to time, but I don’t have a better idea to suggest.

I got to thinking about this last night after – of all things – helping a guy diagnose some errant behavior in the speedometer in his ’56 Chevy. A couple other people chimed in, but their diagnoses were incorrect, because weren’t thinking about how it actually measures road speed. Because, the simple fact is – a speedometer doesn’t measure road speed.

You may find the MIPAR vs. speedometer analogy enlightening. Well, at least I did.

Prior to the introduction of electronically controlled speedometers in the 1980s, speedometer technology had been pretty much the same since at least the early 1920s (earlier ones varied slightly). Here’s how a mechanical speedometer on a rear wheel drive car (like the ’56 Chevy) works:

The output shaft of the car’s transmission turns the drive shaft, which turns the rear axle assembly, which turns the rear wheels. There’s 2 speedometer gears inside the transmission – one mounted on the output shaft, and another that meshes with it. The latter gear drives a flexible steel cable. This rotating cable goes to the speedometer.

Inside the speedometer are two concentric magnetized drums. A coiled return spring, much like the mainspring on a clock, is attached to the outer drum. The speedometer needle is also attached to the outer drum.

As the cable turns the inside drum, the magnetism between the drums overcomes the return spring. The outer drum moves slightly from its resting position – and in proportion to the speed of the cable. As the outer drum moves, the attached needle moves across the calibrated face of the speedometer, giving a reading of miles (or kilometers) per hour.

So, a speedometer does NOT measure the road speed of the car. It measures the rotation of the output shaft of the transmission. While this technique works well regardless of what gear the transmission is in, if you change the gear ratio in the rear axle or the diameter of the tires, the speedometer will no longer read accurately. You then have to change the ratio of the speedometer gears in the transmission to make it read correctly.

Then, there’s the actual speedometer mechanism that sits inside the car. Even if this mechanism is cleaned and lubricated, it still may not read correctly if the magnetism of the drums isn’t carefully matched to the return spring. There’s a special tool used to adjust the level of magnetism on the drums until you get a “pretty good” reading. This adjustment is done by trial and error.

So, you see – no how, no way does a speedometer measure the road speed of the car. It uses several levels of “proxy” to estimate it. Yet – for decades, people depended on this technology to know how fast they were driving.

Now, when I compare MIPAR as a measurement of market exuberance – be it the overall market, or on a given stock – I recognize it too is a proxy method of measurement. It too has things that could cause it to read incorrectly. But, when I compare it with the method used to measure road speed of a car, I think MIPAR is the more robust methodology.

Ted Brooks
Individual Investor

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